From its inception, our federal revenue system has been based on income rather than consumption. Over the year, there have been numerous failed academic and practical proposals to switch to a consumption tax base, mainly for the latter’s promise for greater simplicity and administrability. Accordingly, we came to accept the fact that our system is so deeply ingrained in the concept of income that the transformation to a consumption tax base (such as the VAT and GST prominent in other countries) has become purely theoretical at this point.
Nonetheless, this Article is not another academic exercise. Pratt points out that the switch to consumption tax is extremely relevant today (and even more than ever) in light of the growing inequity gap and erosion of anti-poverty programs. With the diminished share of corporate tax revenues and multinational tax transfers, fulfilment of the growing need for alternative sources of revenues lies with Federal consumption taxes.
Pratt’s starting point is Michael Graetz’s “partial-replacement VAT” proposal. Graetz pairs a broad VAT tax (that resists VAT-reduction benefits and exemptions) with a narrower federal income tax and certain regressivity offsets such as payroll tax credits and distribution of EBT cards. The plan allegedly converts the “mass” income tax into a narrower “class” income tax on high-income taxpayers by providing an exemption from filing a Form 1040 for married taxpayers with less than $100,000 ($75,000 for head of households and $50,00 for single filers). I say “allegedly” because the plan will still tax mass consumption via VAT on goods and services and retail sales. Likewise, taxpayers with value added activity (such as partners, business owners, and sole proprietors) will still need to provide paper-trail of the VAT they create and file VAT-related returns.
Pratt estimates that the partial replacement VAT plan would save tax authorities and American taxpayers about 120 million fewer 1040 tax returns each year. Yet, as opposed to Graetz’s proposal to replace the Earned Income Tax Credit (EITC) with a payroll tax credit, Pratt recommends to pair the Graetz Plan with regressivity offsets such indirect tax transfers in the form of refundable EITC and Child Tax Credits (CTC) for low- and mid-income taxpayers in order to address anti-poverty, liquidity, and distributional concerns. She argues that eliminating payroll taxes to low-income taxpayers under the Graetz Plan will not provide a regressivity offset for the unemployed and will play into “maker-taker” stereotypes that marginalize low-wage workers and justify cutting government transfer benefits. On the other hand, tax-transfer programs such as the EITC and CTC provide positive externalities in the form of reduced recipients’ social stigma, increased take-up rates, and potentially lower administrative costs (but see Anne Alstott’s criticism on the EITC complexity and susceptibility to fraud). To improve the responsiveness and administrability (as well as to lower their associated tax evasion rates) of the EITC and CTC Pratt suggests redesigning the programs’ eligibility requirements, increasing the payment intervals, and coordinating phaseouts better. She argues that this will increase their salience and eliminate the political hype around such transfer payments.
Pratt surveys the recent expansion of child allowances under the American Rescue Plan Act of 2021 and other bipartisan proposals. This includes Senator Romney’s suggestion to improve the social safety net for families with children and replace the IRS-administered EITC and CTC with direct transfers administered outside the income tax system. Pratt adjusts her proposal and indicates that if and when such proposals succeed in moving individual refundable credits out of the income tax, Graetz’s Plan (and hers) will need to be adjusted accordingly.
On the other hand, supporters of mass filing of income tax returns such as Laurence Zelenak provide valid reasons for maintaining tax filing as a civic duty similar to voting in elections. They assert that tax filing promotes the status of citizens as purchasers of civilization and creates a “warm glow” of “fiscal citizenship.” Instead of abolishing tax filing, Zelenak calls for simplification that will improve tax salience and amplify the civic attributes of the tax return filing process. Zelenak, as well as Marjorie Kornhauser, believe simplicity can be achieved by sending taxpayers annual statements of their tax liability and including information on federal spending in the same manner as the Social Security Administration’s periodical statements. As an alternative, Pratt points out that adopting the Graetz plan along with proposals to increase taxpayer voice, agency, and participation can promote the same “warm glow” and “fiscal citizenship” Zelenak conferred.
As for the use of Form 1040 as income verification for non-tax contexts such as applications for loans and financial aid, Pratt reassures that retaining the system of employers and third-party information reporting to the IRS will continue to occur under her proposal. In order to verify their income, taxpayers will still be able to use substitutes to the 1040 Form such as W-2s and 1099s. The IRS can also send out summaries of income as reported by third parties or “ready” information returns. In addition, American households may be able to attest on their ability to pay using financial statements showing income statements, balance sheets, and cash flows. As for tax data collection, federal agencies will need to collect and organize specific data that are necessary to conduct performance evaluations of tax expenditures. Like the federal VAT, states could also adopt a state VAT and narrow income taxes to the high-income taxpayers who still would be required to file income tax returns.
Pratt concludes by emphasizing a major positive externality of adopting the partial replacement VAT proposal—curtailing IRS administration of hundreds of tax expenditures. In her opinion, such as step will provide a catalyst for fundamental tax expenditure reform and will increase the simplicity, administrability, and efficiency of the federal tax system. Enacting a partial replacement VAT and eliminating Form 1040 tax returns would reduce tax system dysfunction and would restore the primary function of the U.S. tax system—raising revenues.